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Copy of Business Presentation
Transcript of Copy of Business Presentation
Task B 1
Cash flow for year 2 is at 629, 375 (income tax of 70,625). If there were no depreciation for year 2 cash flow would decrease to 525,000 for year 2.
The reason for this decrease is with no depreciation expense, you will pay more taxes.
Task B 2
Based on the Net Present Value of the investment being over 17 million dollars and the initial investment being 3.4 million dollars I would advise Entrepreneur D to invest. The investment period desired by the Entrepreneur is 8 years, his investment would be paid back within 5 years with an internal rate of return at 10.861%. This is a smart investment and he will recover his initial funds within a desired amount of time.
The internal rate of return (IRR) is the interest rate at which the present value of the dollars invested in a particular project would equal the present value of the cash inflows from the project. The present value means future cash discounted back to the current period. This interest rate is the break-even point. For a company to invest in the project, it would have to earn a greater return. For example, a project with a $1,100,000 investment, payments of $400,000 in Year 1 and $600,000 in Year 2 with a $250,000 salvage value would have an IRR of 8% (http://www.ehow.com/info_12087321_difference-between-accounting-rate-return-internal-rate-return.html).
The accounting rate of return (ARR) is the average annual income from a project divided by the initial investment. For instance, if a project requires a $1,000,000 investment to begin, and the accounting profits are projected to be $100,000 annually, the ARR is 10%. The advantage of the ARR compared to the IRR is that it is simple to calculate (http://www.ehow.com/info_12087321_difference-between-accounting-rate-return-internal-rate-return.html)
The difference in the figures listed on the chart provided is that the Internal Rate of Return includes working capital requirements while the Accounting Rate of Return does not, hence the difference in the percentages.
The significance of the unadjusted payback period in this decision is because it represents the time that it will take for the initial investment to be paid back. In this case the initial investment will be paid back in 5 years at an internal rate of return of 10.861% and an accounting rate of return at 10%.
According to two Economists, Khizar Hayyat and Saqlain Shah:
Capital budgeting is a long term economics decision. Making it is called capital budgeting, each potential project's value should be estimated using a discounted cash flow (DCF) valuation, to find its net present value (NPV). This valuation requires estimating the size and timing of all the incremental cash flows from the project. (These future cash highest NPV (GE).) The NPV is greatly affected by the discount rate, so selecting the proper rate - sometimes called the hurdle rate - is critical to making the right decision. The hurdle rate is the Minimum acceptable rate of return on an investment. This should reflect the riskiness of the investment, typically measured by the volatility of cash flows, and must take into account the financing mix. Managers may use models such as the CAPM or the APT to estimate a discount rate appropriate for each particular project, and use the weighted average cost of capital (WACC) to reflect the financing mix selected. A common practice in choosing a discount rate for a project is to apply a WACC that applies to the entire firm, but a higher discount rate may be more appropriate when a project's risk is higher than the risk of the firm as a whole (http://en.wikipedia.org/wiki/Capital_budgeting). It should be noted that weighted average represents past figures.
Capital budgeting is a financial analysis utilized to evaluate potential investment projects. Companies need to analyze potential investment returns on future investment projects when planning capital expenditures. A capital investment project is profitable when the project's future cash flows are greater than the amount of capital outlays after adjustments for the cost of using the capital. Alternatively, the internal rate of return, or IRR, for a capital investment project must be higher than the weighted average cost of capital for the project to achieve positive returns (http://www.ehow.com/info_11369298_capital-budgeting-weighted-average-irr-method.html).
Task B 3
Based on the Internal Rate of Return my suggestion is to invest in this product. At this rate of return Entrepreneur D will recover his initial investment of 3.4 million dollars within five years of the investment at a rate of 10.861%.
A decision with regard to IRR can be based on if the IRR is greater than the cost of capital, accept the project as the chart indicates.